The ‘Open for Business’ Tax Plan

Let’s eliminate tariffs and corporate taxes.

Andrew Moylan and Eli Lehrer

December 31 - January 7, 2013, Vol. 18, No. 16

It’s not hard to find people in Washington who say they favor something called “fundamental tax reform.” President Barack Obama, for example, loves talking about the idea. In a major speech at George Washington University and in each budget he has put before Congress, the 44th president has said he wants to “reduce spending in the tax code, so-called tax expenditures” (a good idea, though it strains credulity to suggest that letting people keep more of their own money is “spending”). Without offering any specifics, the president also has endorsed efforts to lower statutory corporate tax rates, while keeping corporate income tax revenue stable by eliminating credits, deductions, and exemptions.

GOP plans—even those in the supposedly radical, House-passed, Paul Ryan-authored “Path to Prosperity”— involve similar base-broadening cuts in the corporate rate and promise to do away with some unspecified “loopholes.” These “radical” Republican plans would probably be better for growth but actually share a lot of features with President Obama’s proposals.

While Democrats and Republicans agree that America needs to reform its corporate tax code, both sides have offered plans that essentially nibble around the edges by reducing carve-outs and lowering statutory rates. This isn’t fundamental reform. Indeed, the best one can hope for in any reform that emerges in 2013 would be something resembling the Ronald Reagan/Dan Rostenkowski/Dick Gephardt/Bill Bradley effort in 1986. The Tax Reform Act of 1986 was a well-thought-out bipartisan simplification of a shaky federal tax structure, yet the code quickly morphed into the 3-million-word mess we have today, loaded with special favors and loopholes of the very sort that Reagan-era leaders fought to remove.

A truly fundamental reform would be outright elimination of tariffs and corporate income taxes, two features of the tax code that nearly all right-of-center economists—and a surprising number of left-of-center economists—believe are damaging to growth and prosperity. Call it an “open for business” tax strategy, welcoming global capital to our shores and thereby stimulating the domestic economy.

Tariffs, which are just import taxes, are an anachronism that hurts consumers and the overall economy. While industrial unions and some of the older smokestack industries love the protection of tariffs, few economists of any ideological stripe would endorse them today. The NAFTA and CAFTA trade deals have eliminated most tariffs between the United States, Canada, Mexico, and much of Central America, but duties imposed on products from other countries raise prices for consumers and encourage misallocation of productive capacity.

The burden of tariffs falls most heavily on lower-income consumers, who spend relatively large portions of their income on overseas-produced and heavily tariffed goods like clothing and food. Furthermore, the relatively low-wage jobs that tariffs could theoretically “preserve” frequently come at the expense of new jobs that otherwise would have been created in more dynamic and remunerative sectors of the economy.

Moreover, for all the trouble they cause, tariffs bring in a relatively paltry $30 billion in revenue, less than 1 percent of the federal government’s total take. Their elimination could easily be financed by closing a handful of loopholes that few would miss, such as tax subsidies for wind energy boondoggles and mortgage interest on multi-millionaires’ mansions. Because tariff rates are reasonably modest, eliminating them might not make a huge difference for the economy as a whole. But the move would send a powerful signal to anyone seeking to do business with Americans while providing a counterweight to protectionism here and abroad.

The elimination of tariffs remains a topic of interest primarily to professional economists. In contrast, lots of people are talking about corporate tax reform. Alas, the reforms under consideration would be fairly minor. Democrats and Republicans alike want to end a variety of deductions and credits to lower the statutory corporate tax rate, but the most commonly proposed changes would fail to lower rates to levels that are competitive by international standards.

By any measure, America’s corporate income tax code is among the most burdensome in the world. The marginal rates are the highest of any industrialized country and effective rates are higher than all but a handful of First World economies. Even if America is very aggressive in broadening the base and lowering rates, it’s likely that it will only move to the middle of the First World pack. For a country aiming to be a global leader, “average” shouldn’t be enough.

Zeroing out the corporate income tax, on the other hand, would make the United States dramatically more competitive. The benefits of such a policy would also be more broadly distributed than just about any other similarly sized tax reform one could contemplate. Most important, it would likely raise workers’ wages and benefit consumers.

While the literature on who actually “pays” corporate taxes (what economists call “tax incidence”) is complicated, it’s clearly impossible for corporations themselves to pay taxes, since they are simply composed of individuals. Taxes assessed on a corporate treasury are inevitably passed on to three groups: shareholders, employees, and customers. While most corporations will pass on some burdens to each of these groups, employees are often the most vulnerable. After all, consumers can usually find competing products and shareholders can sell the stock. Unless their skills are in high demand, however, workers have to go through a long search to find other employment.

One study, from Harvard and the University of Michigan, finds that as much as three dollars out of four in corporate taxes are paid by a company’s workers. The Congressional Budget Office, likewise, finds that ordinary individuals end up paying most of the tax. And as with tariffs, there’s reason to suspect that low- and moderate-skilled workers who are unable easily to switch jobs and who spend a large portion of their income on consumer goods bear a disproportionately larger share than the executives that populist advocates imagine pay the bill.

While the roughly $240 billion the federal government collected this year in corporate income tax isn’t pocket change even by Washington standards, it’s not so large that it would be impossible to do without it. Part of the lost revenue would be paid through higher dividends, capital gains, and incomes that would result. (The money has to go somewhere, after all.)

Finding a replacement for the remaining foregone revenue would require some other source. While many on the left likely would suggest simply raising personal income taxes on the well-off, it might also make sense to look at broader sources of revenue, like taxing consumption, energy use, industrial pollution, or a carbon tax that might combine all three.

A zero corporate tax isn’t quite as radical as it sounds. Most of the other 33 countries in the Organisation for Economic Cooperation and Development already have “territorial” tax systems that only tax profits earned within their borders. The “worldwide” tax system of the United States adheres to no such limit, and, as a result, companies try to attribute as much income as possible to lower tax, non-American jurisdictions. Every truly large non-U.S. company already has some never-taxed profits, so long as they never repatriate their earnings (something Ryan and other Republicans favor letting U.S. companies do too). Eliminating America’s corporate income tax would, in part, just level the playing field and bring more business operations under U.S. jurisdiction.

The politics of eliminating the corporate tax, although sure to arouse populist drum-beating, might not be quite as difficult as they seem at first blush. The idea has gained some real currency on the left, where advocates like former Labor secretary Robert Reich have argued convincingly that doing away with the corporate tax would not only raise wages but also reduce corporations’ incentive to play politics in the first instance.

A policy of zero tariffs and no corporate income tax is practical and would do immense economic good. Beyond its obvious benefits for consumers and the economy as a whole, such a policy would send the world a clear message that America is a global competitor with its doors wide open for business.

Andrew Moylan is outreach director and senior fellow and Eli Lehrer president of R Street.